By Perrie Michael Weiner (pictured) and Patrick Hunnius at international law firm DLA Piper – In the past few weeks, there has been much press attention and debate regarding the legal issues raised by “activist” investors who (as part of their bullish or bearish campaigns for or against companies in their sights) “tip” other investors about their planned campaigns and their accumulation of long/short positions.
For example, the Wall Street Journal, in an article called “Activist Investors Often Leak Their Plans to a Favored Few,” focused on instances where “activists” “sometimes provide word of their campaigns to a favored few investors days or weeks before they announce a big trade, which typically jolts a stock higher or lower.” The article noted that an SEC spokesman “couldn’t recall the agency having brought a case in the area,” but also said that “the SEC has increased its focus on activist investors’ moves, including whether there is proper disclosure” and that the SEC is investigating “whether some hedge funds were working together to try to profit ahead of public disclosure of an investment stake.”
Earlier this year, and virtually unnoted until now, the SEC explicitly warned hedge fund compliance officers that this type of collaborating is a “risk to be mindful of” and would “cross the line.”
In January 2014, the SEC presented its annual National Seminar as part of its Compliance Outreach Program. At the seminar, the SEC staff in attendance specifically identified “non-public information about clients/funds” as a risk for hedge funds. Ashish Ward, an Exam Manager in the National Exam Program, described the types of “non-public information about clients/funds” the SEC is concerned about: “information about your hedge funds themselves,” “what exactly they are holding,” and “what exactly that they are trading.” Mr Ward elaborated:
We understand common practice in the hedge fund business is to share investment ideas about companies, but you want to make sure those conversations don’t go so far as to actually discuss what you are actually doing right now….that would be information that’s non-public.
Mr Ward further noted that while funds may make quarterly, backwards-looking filings that reflect their holdings, those filings do not show “what you held yesterday, today or what you intend to trade and that’s where you could cross the line and… disclose non-public information about your fund holdings.” (emphasis added)
The SEC staff at the Outreach Program offered another warning that could have a further chilling effect on discussions by or among fund managers: they identified “collaborating on ideas with other managers” as another risk for funds, without elaborating further on what forms of “collaboration” or “ideas” would be frowned upon.
It is unclear if the view expressed by the staff is the prevailing view among SEC examiners or SEC Enforcement staff (or the Commissioners themselves). Nor is it clear what “line” the SEC staff believes is being crossed. What is more clear is that the staff’s statements do not appear (to us) to be an accurate statement of the law. For example, there is no per se prohibition on fund managers sharing “non-public” information, particularly where the “non-public” information is information that belongs to them or the fund (e.g., the funds’ holdings, intentions, etc.).
Nor is there a per se prohibition against trading on the basis of “non-public” information. As the SEC’s website helpfully points out, insider trading generally requires both that a trade involve material, non-public information and that the trade is “in breach of a fiduciary duty or other relationship of trust and confidence.” And that second element is missing in the scenarios the SEC warned funds against.
Whether the SEC staff’s aggressive views regarding information sharing and collaboration – commonplace features of the new “activism” -- will result in a new wave of SEC investigations and enforcement actions is anyone’s guess. We suspect the SEC may revisit using its rulemaking authority to shorten the time period during which a stockholder owning more than 5 percent of an issuer’s securities must report their ownership (by filing a Schedule 13D). The time may be ripe for the SEC to reexamine the 13D window, in part because the reaction to the Journal article and, more recently, to significant (unrealized) gains achieved by activists working in tandem has been quite sharp. For example, William D. Cohan, writing in the New York Times’ DealBook, asked “how can it be acceptable” for “hedge funds to share material, nonpublic information privately with one another about their investment ideas.”
It should be acceptable because it appears, at least on its face and according to prevailing law, to be legal. But, of course, legality is not a panacea much less a shield against investigation.